Weakening world economies – an odyssey from debt to tribulation

Forces of nature, such as gravity, cannot be suppressed forever, and we remain cautious about the stock market, looking for signs that fundamentals might matter again.

In the meantime, a nation’s economy does not exist in a vacuum, and decoupling world economies is more tricky than decoupling markets. Accordingly, while the economic outlook in the US is raising speculation about a recession, the outlook in Europe is worse. And China, the world’s second largest economy, is also slowing down.

Mish surmised: “China manufacturing is contraction, not growth. Moreover, the European recession is strengthening and a US recession is underway (just not recognized yet in my opinion). Thus it would be logical to assume China’s export-driven economy is going to take another hit.

Micheal Pettisargued that commodity prices will drop hard in the next few years due to a combination of increasing production, decreasing demand, and selling pressures in the stockpiles of commodities that have been accumulated. Production of commodities takes time and capital investment. There is a lag between the time when producers see prices increasing due to demand, and when they can ramp up production. When production increases and demand falls, these capital intensive industries are usually late to notice and react. As a result, prices start falling. As the oversupply sits, the price decline accelerates. (By 2015 hard commodity prices will have collapsed)

Coal is a prime example of a commodity that goes through this demand/supply/price movement cycle on a regular basis. It is used in the generation of electricity and the formation of metals, namely steel. Steel is made from iron ore, and iron ore prices have already fallen by more than 50% as a glut of steel sits available to move into the market.

Metallurgical coal (MC) is used to smelt iron ore to make steel. Companies such as Alpha Natural Resources (ANR) and Arch Coal (ACI) are suppliers of MC. Their shares have been hit due to the lower costs and oversupply of MC, the slowdown of Chinese steel mills, and the decline in Japanese manufacturing. The slowdown reflects an unhealthy Chinese economy. Plunging U.S. durable goods is not helping the situation.

According to Mish, “Looking ahead, the widening rift between Japan and China over disputed islands certainly cannot help, yet Voice of America reports there is No Sign of Progress in Dispute.

“‘Relations have sunk to their lowest point in years, with anti-Japan protests breaking out across China and many Chinese refusing to buy Japanese-made goods. On Wednesday, Japanese automakers Toyota and Nissan said they are reducing production in China because of lessened demand.”

Socialist President Francois Hollande unveiled an austerity budget which included increasing taxes for businesses and the superrich. Mish noted, “The top tax rate in France is now 75% for those who make over a million euros. Moreover, there is a new band of 45% for those who make over 150,000 euros. Don’t forget the existing VAT on all purchases.

“The French Finance minister is ‘certain that if Europe steadies, France will achieve 0.8 per cent growth or more.’ That is about as meaningful as this statement by me ‘I am certain that if I had a billion dollars, I would be a billionaire.’

Writing in the Guardian, John Carlin, summarized the situation in Spain: “Here’s the news from Spain last week, in case anybody missed it: huge cuts in government spending; higher taxes; biting austerity; unemployment higher than in Greece; big and growing demonstrations in Madrid; violent clashes with police; and in Catalonia, a rising clamour for secession. The only hope on the horizon takes the ambiguous form of an expected financial rescue package, with still more austerity strings attached, from the richer countries of the north.”

John suggested that a rescue package will only provide temporary relief because Spain needs to address a deeper problem that has impaired its ability to be a “competitive global player.” The problem is called “amiguismo” or “friendism.” “Amiguismo” describes a system in which success depends on who you know. While it is inherent in all societies, John asserts that is it extreme in Spain, embedded in its DNA.

John blames the government in part but also believes it is not a root cause. “What’s needed if Spain is not to sink gradually back into a sort of bucolic, early 20th-century Mediterranean poverty is a revolution across the board in attitudes to work. Like it or not, the system has to be overhauled and replaced by one where the rules are fair and merit is rewarded. Everywhere.” (Cronyism Is Destroying Spain’s Future)

GERMANY

Phoenix Capital Research argues that the Germany economy is very vulnerable to the US Dollar’s demise, which appears to be the end point of QE-Infinity game Bernanke is playing. “Over 50% of Germany’s economy is based on exports. So if the US Dollar continues to fall, Germany’s economy will implode. This in turn will put Europe in an even bigger bind as its primary backstop, Germany, will be facing a serious recession at the very time that Spain and Italy start asking for bailouts (sometime in the next 3-4 months).”

Reviewing the dire situation in Greece, Mish wrote, “While the bickering between France, Germany, and the Troika continues, Greece grapples with shadow of Golden Dawn… This cannot possibly end well, whether or not Greece gets a time extension.”

Golden Dawn is a right-wing extremist group. While the media describes it as neo-Nazi and fascist, the group rejects these labels. Nevertheless, they have used Nazi symbolism and praised figures of Nazi Germany in the past. The party’s leader Nikos Mihaloliakos admits that the party is nationalist and racist. (Wikipedia)

GLIMPSES

We do not see a happy ending to the economic hardships and strife that most of the world is facing. That said, the deterioration in world economies and social unrest have not been key drivers of the US stock market. That leaves us in a state of cognitive dissonance while we attempt to get a clear view of the market, minus the negative biases we build up watching economic stability and social cohesion unwind in sometimes violent ways.

To determine how much of QE-Infinity has been built into the stock market (due to front running before the announcement), Zero Hedge analyzed the S&P taking into account David’s Rosenberg’s findings that every $40 billion of QE added to the Fed’s balance sheet adds about 20 points to the S&P 500.

“With global growth slowing, global trade tumbling, and earnings revisions falling rapidly, equity market outperformance has been (as we noted earlier) based on the Fed/ECB’s largesse. The unanswered question is – how much is now priced in? Given recent ‘stability’ post-FOMC, it seems the follow-through is not there (especially if we look at sectoral performance) and based on David Rosenberg’s estimate of Fed QE’s impact on stocks, we think we know why. In the last three months, the S&P 500 has ‘outperformed’ the Fed balance sheet by around 220 points – which equates to a pricing-in of around 11 months of additional QEternity.

Zero Hedge is suggesting that 11 months of QE have already been priced into the stock market. If this is the case, new QE3 money will not alone be sufficient to keep stock prices floating higher. If Liquidity has left center stage, there might be room for other factors to reassert some influence.